The Ins and Outs of Bond Yield

Step 6: How Should I Interpret My Bond's Reported Return?

What the Numbers Tell You

To sum up, when you buy an individual bond, you will be quoted the price of the bond, the coupon yield, its current yield, its years to maturity, and its yield to maturity.

What does this information convey?

The coupon yield will tell you how much income you will receive each year you own the bond.
The current yield will tell you how much interest income you will receive each year relative to the price you are paying for the bond.
You will also know that if you hold the bond to maturity, on that date, you can redeem the bond at par.
The yield to maturity will give you an estimate of the total return of the bond, assuming the bond is held to maturity and all coupons are reinvested at a rate equal to the yield to maturity.
The YTM will not be your actual return. Your actual total return will be determined by a number of factors, including whether you spend dividend income or reinvest it; the rates at which you reinvest coupons; and the difference between the price you pay and your selling (or redemption) price.

When you buy a bond fund, on the other hand, you will be quoted the fund's 30-day SEC yield. What does that information tell you?

The 30-day SEC yield is a variant of the current yield quoted for individual bonds. It is not comparable to the YTM quoted for individual bonds. However, it will tell you how much interest income you can expect to earn from the fund.
Future total returns for a bond fund will be determined partly by some of the same factors that determine total return for individual bonds. But you cannot predict the price at which you can sell your bond fund at any future date.

Returning to our initial question, you can now figure out what your newspaper was telling you. If a bond fund posted a total return of 10% for the past year, you can puzzle out how much was due to dividend income and how much was capital gains. If the fund's quoted 30-day SEC yield was approximately 5%, then you now realize that last year, the 10% total return consisted of about 5% interest income and 5% gain in the price (NAV) of the fund. The interest income for next year will be approximately the same. The total return, however, will depend on the direction of interest rates.

A Guide to Yield and Total Return

Coupon Yield: The simple interest paid by a bond annually. It is set at the time of issue, and expressed as a percentage of par. A $1,000 bond with a 10% coupon will pay $100 per year, generally in two installments of $50.

Current Yield: The coupon paid by a bond divided by the bond's market price. It measures the income from a bond relative to its current cost.

Yield to Maturity: An estimate of the total return of a bond assuming it is held to maturity and that all coupon income is reinvested at a rate equal to the yield to maturity. The yield to maturity takes into consideration all possible sources of income—coupon income, interest-on-interest, and capital gains or losses due to the difference between the price paid when the bond was purchased, and par, the return of principal at maturity.

Total Return: Interest income (simple interest plus interest-on-interest) plus gains or minus losses in principal. To be totally accurate, you should also subtract taxes and commission expenses.

30-Day SEC Yield: A yield quoted by bond mutual funds, calculated according to a formula determined by the SEC—primarily a snapshot of the interest distributions from the fund over the prior 30 days, but also includes slight price increases (for discount bonds) or price decreases (for premium bonds) of bonds in the portfolio as they move toward par. The figure is a reflection of the past 30 days and is not necessarily an indication of future return.

TEST YOUR KNOWLEDGE ⟫